|by Daniel F. Dovi and Craig R. Tractenberg
The two cases involved disputes between School of Rock and two of its franchisees—Smith and the Giammarrusco’s, who together conspired to repudiate their franchise agreements to start a competitor, Rock Nation (the “Smith” and “Rock Nation” cases respectively). The cases share largely identical facts. Each involved California franchisees, breach of the respective franchise agreements, and similar claims including non-payment of royalties to School of Rock. Both cases also involved franchise agreements that contained arbitration and non-compete clauses. The major difference between them is that the franchise agreement in Smith provided for arbitration in Pennsylvania pursuant to Pennsylvania law, while the franchise agreement of the Giammarrusco’s in Rock Nation required arbitration in California under California law.
Unlike Pennsylvania law, California law considers covenants not to compete to violate public policy—an important distinction between the two states. California law generally prohibits such covenants, and California courts rarely enjoin competition, doing so only when necessary to protect trade secrets.
The Smith case proceeded to arbitration in Pennsylvania. Ultimately, the arbitrator ruled that Smith must pay $401,743 in damages including attorneys fees and future lost profits to School of Rock, and that he was bound by the non-compete clause in the franchise agreement. The arbitrator was not bound by the prohibition on restrictive covenants found in California. In contrast to Smith, School of Rock’s arbitration award in Rock Nation awarded $100,000 in damages for unfair competition with no damages for future lost profits. The arbitrator also refused to uphold the non-compete clause as against California’s public policy but is increasing the award to add costs and counsel fees.
These cases provide franchisors with an important guide for constructing
franchise agreements for use in California. However, the extent
to which clauses choosing non-California law are enforceable in
California franchise disputes is not completely clear. Prior to
the arbitration in Smith, Smith objected to the choice
of law and forum provisions in a California court, arguing that
the provisions were unconscionable. However, the court found that,
since Smith’s California rights would be recognized in Pennsylvania,
the provisions should be enforced. Notably, not all California
cases since Smith have been similarly decided. Recently, in Bridge
Fund Capital Corp. v. Fastbucks Franchise Corp., the court
refused to follow Smith. The court found that the choice
of forum and law provisions in the franchise agreement, which
designated Texas and Texas law, were not enforceable since there
was no evidence that the franchisee’s California-based rights
would be recognized in Texas.